The proposed goods and services tax (GST) crossed a major hurdle after Indian states on Monday agreed to a compensation formula for central sales tax (CST) suggested by the centre, but drove a hard bargain for the next few years.

States will be given 100%, 75% and 50% of the compensation figure arrived on the basis of the guidelines of 22 August 2008, for the years 2010-11, 2011-12 and 2012-13, respectively. This could cost the exchequer around Rs.34,000 crore for the three years, according to initial calculations, said Sushil Kumar Modi, chairman of the empowered committee of state finance ministers and also the deputy chief minister of Bihar.

“The centre has said that a staggered payment will be made,” Modi said on Monday. “This year’s budget will have some provisions.”

At the two-day meeting of the group in Bhubaneswar, states have asked the centre to evolve a mechanism to pay compensation due to them for the next few years till the GST regime is rolled out. Even after that, states want a plan for compensation of losses to them due to GST and CST for five years after the implementation of GST, as was done during the rollout of value-added tax.

“The states do not want to take a begging bowl to the centre asking for compensation,” Modi said. “They want a definite time-frame and mechanism for the payment.”

Some states that have significant industrial manufacturing activity and foresee huge losses have even asked for an increase in CST from 2% back to 4% to compensate them for the losses till GST comes in. CST was cut to 2% as part of it being phased out before the introduction of GST.

“The centre has promised that the issue of CST compensation for the year 2013-14 will be considered. But it also cited fiscal constraints while agreeing to only 50% in 2012-13,” Modi said. “Some states are of the view that if there are fiscal constraints, CST should be again increased to 4%.”

States such as Gujarat, Andhra Pradesh, Haryana and West Bengal were those that incurred huge losses.

Finance minister P. Chidambaram constituted two committees in November last year, with officials from both the centre and states, to look into the issue of CST compensation and the design of GST. The panels submitted their reports on 21 January. The empowered committee of state finance ministers will discuss the issue of GST design on Tuesday.

The implementation of GST, a tax reform that will remove all barriers across states, has been delayed due to differences between the centre and the states over its final design and the issue of CST compensation.
States have asked that the level of CST compensation number be based on the principles laid down in the 2008 agreement between the centre and states defining this.

The guidelines didn’t specify that the CST payout will be reduced because of an increase in value-added tax by some states to 5% from 4%, or because some states get additional revenue because of taxes on items such as sugar, tobacco and textiles.

States had demanded a compensation of Rs.19,000 crore in 2010-11, of which only around Rs.6,000 crore was paid by the centre. States had cut CST as part of the transition to GST, with the centre compensating for the revenue forgone. However, some states such as Madhya Pradesh continue to oppose the lesser CST payout by the centre.